The Fed’s $2.7 trillion mortgage problem

Data: Federal Reserve;  Diagram: Axios Visuals
Data: Federal Reserve; Diagram: Axios Visuals

If you’ve taken out a mortgage in the past few years, there’s a good chance that the holder of that loan is the US Federal Reserve – a result of its monetary stimulus efforts during the pandemic.

Why it matters: The Fed will face a host of political and economic problems as it tries to move away from subsidizing home loans by shrinking its portfolio of mortgage-backed securities.

  • The problem: Pulling out of this market risks crashing the housing industry and creating an intense political stroke for financial loss.

Using the numbers: As of February 2020, the Fed owned $1.4 trillion in mortgage-backed securities and the number was rapidly declining. But as the pandemic took hold, the central bank launched a new round of asset purchases (known as “quantitative easing”), taking that number to $2.7 trillion.

  • The policy contributed to ultra-low mortgage rates, which until recently stimulated home buying and refinancing activity.

Game Status: Now, as the Fed tries to tighten monetary policy to fight inflation, it wants to downsize this portfolio. It may turn out to be easier said than done.

  • The Fed says it will reduce the mortgage portfolio by up to $35 billion a month through September. Emphasis on “up to”.

As a matter of fact, the numbers will probably fall short of that.

  • The reason: For the time being, the Fed is only trying to let its holdings shrink when securities are paid off. But with mortgage rates rising sharply in recent months, people have little incentive to sell their home or refinance a mortgage — so those mortgages are likely to stay on the Fed’s books longer.

That will leave the Fed with unattractive options. It might simply accept that it will continue to play an outsized role in the housing market and a larger balance sheet than it might wish.

  • Or it could start selling the securities on the open market –– a possibility that, according to the minutes of its policy meeting in March, could come later.

What you say: “Let’s get the program that we have going and update it, but once we get it going I think it’ll be worth taking a look at what’s happening with the mortgageee [securities] on our balance sheet,” Thomas Barkin, President of the Federal Reserve Bank of Richmond, told Axios.

  • “I’m certainly open to a focused and disciplined way of selling in the market if we’re not moving towards the primary Treasury balance sheet that we’ve said we want,” he said.

Yes but: That will work his own problems. If the Fed sells low-yield mortgage securities at a time when prevailing interest rates are much higher, large financial losses are incurred, reducing the funds that the central bank returns to the Treasury.

  • In this scenario, expect officials to have to face tough questions from Capitol Hill to explain why they lost billions of dollars on behalf of the American people.
  • Also, the sales would likely push mortgage rates higher even as the housing industry is already beginning to groan under the pressure of rising interest rates. Home builders, real estate agents, and other influential industry groups will take their discontent to elected officials.

The bottom line: The Fed’s pandemic measures have fueled a housing boom. If it attempts to withdraw that support, it could be bad news for housing construction – and for the Fed’s standing on Capitol Hill.


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